* Better-than-expected PMIs send yields higher
* Strategists say rebound takes onus off ECB policy
* Italy outperforms after summer supply cancelled
* Cash drop lifts money markets, short-term yields eyed
By John Geddie
LONDON, July 24 Euro zone bond yields edged up
on Thursday as investors saw better-than-expected economic data
as quelling the need for the European Central Bank to loosen
monetary policy further.
Germany - the bloc's economic engine room - was set to
record the fastest growth rate for three years in its services
sector, preliminary data showed, seen fuelling an impressive
expansion in the euro area's private sector.
The data pointed to an upturn in the health of the euro zone
economy, which has been propped up in recent months by
ultra-easy ECB policy that has in turn pinned government
borrowing costs at record lows.
Strategists said that without signs of recovery, markets had
expected the ECB to embark on quantitative easing via a
programme of asset purchases - a prospect that has now
"The data came against the trend," said Piet Lammens, a
strategist at KBC.
"The market had discounted too much a situation where there
is no quantitative easing, so you would expect yields to go
German 10-year yields edged 2 bps higher on Thursday to 1.17
percent, while all other euro zone bond yields edged higher by
between 0.2 and 2.2 bps.
Italian 10-year bonds reversed earlier gains but were still
some of the best performing assets relative to their peers, with
yields up just 0.2 bps at 2.74 percent.
Traders said Italy's decision to cancel scheduled bond
auctions in mid-August had created more demand for peripheral
bonds in the secondary market.
MONEY MARKET PRESSURE
Euro zone money market rates edged higher on Thursday and
were expected to rise further in coming days, potentially
driving up short-term government bond yields, after a drop in
excess cash in the bloc's banking system.
The euro overnight interbank lending rate moved
back up to the top end of its recent trading range on Wednesday,
analysts said, while forward rates imply it will almost double
by the European Central Bank meeting in September.
"The market is pricing in this scenario we have been
expecting all along - one with downside risks to liquidity and
upside risks to rates for most of this summer," said Christoph
Rieger, a strategist at Commerzbank.
The spare cash in the euro zone banking system dropped to
104 billion euros on Thursday, its lowest in over a month, after
a bumper 21 billion euros of long-term loan repayments by banks
"This will have an upwards pressure on Eonia. From currently
around about 5 (basis points), I could see it move up to 8,
maybe 9," said RBC's head of European rates strategy Peter
A push higher in money market rates should also see
short-dated bond yields rise more than those on longer-term
bonds, strategists said.
Commerzbank's Rieger said German bond futures already show
this trend with two-year Schatz futures close to their lowest in
a month and 10-year Bund futures at one-month highs
Strategists predict this trend will continue during the
northern summer months, but that the liquidity squeeze is likely
to ease in September when the European Central Bank offers its
first round of targeted long-term loans to banks.
(Editing by Nigel Stephenson and John Stonestreet)